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John Bair
John Bair
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Implications of the American Taxpayer Relief Act

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At the beginning of January, Congress passed H.R. 8, the American Taxpayer Relief Act (ATRA). If your clients elect to take their settlement recovery in a lump sum payment, that influx of income could have a significant impact on their ability to maximize their settlement recovery. As attorneys, you may want to also consider the effect that the ATRA will have on your ability to maximize your attorney fees.

In brief, the biggest implications of the Act are:

Income Tax Rates

  • Tax brackets for individuals making less than $400,000 per year will remain at 10%, 15%, 25%, 28%, 33%, and 35%
  • For individuals making over $400,000/year, head of household filers making over $425,000, and joint filers making over $450,000, the taxation rate will be 39.6%

Taxation of Capital Gains and Dividends

  • The tax rate for investment income will increase to 20% for the highest-income earners (i.e. $400,000 for individuals, $425,000 for heads of household, and joint filers exceeding $450,000)
  • Taxpayers whose regular income is taxed at a rate of 25% or above will have their capital gains and dividends taxed at the 15% rate.
  • Taxpayers whose regular income is taxed at a rate below 25% will not be taxed on their capital gains and dividends
  • The 3.8% surtax (sometimes referred to as the “Medicare Surtax”) on investment-type income will stay in place; for more information about how the surtax is calculated, click here

Exemptions for High-Income Earners

Exemption and deduction phase-outs for high-income earners begins for filers at the following levels:

  • $250,000 individuals
  • $275,000 head of household
  • $300,000 joint filers

Payroll Taxes

  • The Social Security portion of the FICA tax is raised from 4.2% to 6.2%

Alternative Minimum Tax

  • The permanent exemption amount, which is retroactive to 2012, for determining alternative minimum taxable income is $50,600 for iIndividual and head of household filers, $78,750 for joint filers, and $39,375 for those who are married, but filing separately
  • The amount will be indexed for inflation
  • Retroactive to the 2012 tax year, the use of nonrefundable personal tax credits are permitted to offset the taxpayer’s entire AMT liability

Individual Tax Breaks

Certain individual tax deductions and credits will remain in place for five years:

  • Earned income credit (EIC)
  • Child tax credit
  • Qualified college tuition

Business Tax Breaks

Certain business tax deductions and credits will remain in place for a limited time:

  • Section 179 expensing limits (allows smaller businesses to immediately write off full price of qualifying asset purchases rather than depreciating them over several years) were raised to $500,000, with a phaseout threshold of $2 million
  • Bonus depreciation allowance (i.e. 50% depreciation allowance) extended to allow deductions of half the cost of qualifying property
  • Tax exclusion of gain on qualified small business stock disposition

Mortgage Debt Relief

  • Those homeowners who avoid foreclosure by utilizing a short sale will not be taxed on the amount of mortgage debt forgiven at closing

Mortgage Interest Deduction

  • Homeowners can continue to deduct the amount of interest they pay on their mortgages

*Unless otherwise stated, provisions of the ATRA apply to tax years beginning in 2013

Disclaimer: Milestone Consulting, LLC does not provide legal or tax advice. Please consult a tax advisor is you have questions regarding the taxable/tax-free elements of a proposed settlement. For more information regarding tax rates, please visit http://www.irs.gov.

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Knowing Your Client: 3 Ways to Avoid Financial Pitfalls in Litigation

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